Counting the cost: calculating the price of an (un)healthy ecosystem

If an individual or company incurs no cost for pollution, there is no economic …

When confronted with environmental problems, difficulties often arise in the accounting. Just how much is a particular problem costing the economy? How much is it affecting human health? It's difficult enough to assign an economic value to health and well-being, but how do you put one on a particular species of plant or animal? Natural beauty itself can also have an economic impact. Given the complexities, we often settle for calculating the economic cost of addressing an environmental issue. That's often a much easier number to calculate (although the results can be intimidating), but it doesn't capture the full value of environmental services.

A similar problem emerges when attempting to include environmental degradation into the cost of a product or service. You may pay for the materials, labor, marketing, and shipping of a product, but what about the cost of the pollution associated with it? If an individual or company incurs no cost for that pollution, there is no economic incentive to avoid it. The cost will be borne, in a distributed fashion, by the population as a whole. These costs are referred to as "externalities" because they have no effect on the market.

A policy article published this week in Science argues for improvements in how we include ecosystem services in free market interactions. The authors point to the Millennium Ecosystem Assessment’s conclusion that 60 percent of ecosystem services have declined over the past 50 years, noting, "This is not surprising: We get what we pay for." Governments around the world are beginning to implement policies to change that, but the article warns that poorly designed schemes, though well-intentioned, can actually make the problem worse.

Failure often arises, the authors write, when pricing schemes do not accurately track changes in the resource or service, or do not include all the costs associated with its degradation. It can be very difficult to design robust market-based programs that do so. As an example, they mention recent complications in the US cap-and-trade market for sulfur dioxide emissions, which was instituted in 1990 to curb the pollution that causes acid rain.

Rule changes meant to address flaws in the program were struck down in court in December 2008, and the resulting uncertainty quickly drove the price of emissions allowances to zero, which is about where they’ve stayed since. While the EPA scrambles to implement a replacement plan that can survive legal challenges, emitters have virtually no financial incentive to invest in pollution controls.

Other schemes fail to account for interconnected ecosystem services. If programs that encourage biofuel cultivation cause the clearing of tropical forests for farmland, the net result could be counterproductive. Ecosystem interactions are complex, and effective solutions can be elusive.

The authors also stress that attempts to kill two unrelated birds with one stone (for lack of a less ecologically hostile expression) are rarely successful. Here they refer specifically to agricultural programs that aim to assist the poor, stating, "Poverty reduction is a laudable goal," they write, but money spent tackling it should should signal any reductions in ecosystem services. (In other words, the money should stop flowing if it would induce environmental degradation.) Inefficient ecosystem protection ultimately impacts poor farmers, so bundled programs don’t help them in the long run.

There are ways for governments to tailor successful schemes, but they require a series of questions to be addressed. Policy makers may need to choose among a cap and trade system, simple regulation (with fines for violations), and direct payments to subsidize ecosystem preservation. The authors also suggest a number of factors that should be considered. For starters, what type of public good is being protected? Is that affected by many parties (think fisheries) or a few (think air pollution)? Is its value determined by the best sample (habitat) or the weakest (storm protection)? Finally, will the rewards be seen immediately, or is it an investment in the future?

Jurisdiction can be another hurdle, as issues may be local, national, or international. Those who protect the resource may be geographically disconnected from those who benefit from it (again, think air pollution).

Even if well-designed programs are implemented, the difficulty in assessing the economic worth of ecosystem services remains. Because of this, the authors call for expanded use of environmental metrics, and suggest they be considered alongside traditional economic measures of national wealth. (The United Nations System of Environmental and Economic Accounts represents one attempt to do just that.) Such a metric would make clear the distinction between exploiting a natural resource and managing it sustainably.

America got rich by NOT paying for the environmental costs associated with business. Our for-fathers came upon an unspoiled land and got rich exploiting the environment (and cheap immigrant labor) through harvesting timber, mining, turning grasslands into wheat fields and whaling.

The question is how to we stay rich now that the environment has to be taken into consideration?

It all boils down to the issue that the Rich (developed world) are willing to pay for a cleaner environment, but the Poor (developing world) have not attained a level of income yet to care. Sustainability is not the first priority if you are making $2 a day, surviving is.

That's why China rejected the Green GDP that hanser mentioned above. Its why China will continue to reject CO2 caps and basic environmental protections the US EPA has had for years.

Coming out of an Environmental Economics class, to achieve a long-term reduction in environmental degradation, there must be significant poverty reduction, as otherwise the individual and national incentives to conserve are not there.

If an individual or company incurs no cost for pollution, there is no economic incentive to avoid it.

Not only is there no incentive to avoid it, but there is a positive incentive to make sure that there is no cost in the future. Understanding this gives understanding to a good portion of American politics. Paying lobbyists to prevent anti-pollution laws, and PR men to cynically push the 'anti-pollution regulation is anti-business' political message is often a better investment (from the purely monetary point of view) than actually cleaning up the pollution.

The whole global warming doubter movement, backed with billions of dollars by the coal industry, is a good example.

While trying to assess externalities can certainly make for a more efficient marketplace overall, I think it's helpful to remember that there are *also* external benefits as well as external costs. Focusing on just one side of the ledger does not actually help us paint a more accurate picture.

While trying to assess externalities can certainly make for a more efficient marketplace overall, I think it's helpful to remember that there are *also* external benefits as well as external costs. Focusing on just one side of the ledger does not actually help us paint a more accurate picture.

While trying to assess externalities can certainly make for a more efficient marketplace overall, I think it's helpful to remember that there are *also* external benefits as well as external costs. Focusing on just one side of the ledger does not actually help us paint a more accurate picture.

Positive externalities associated with pollution? Do tell.

Not with pollution specifically, but with commercial transactions generally.

One example right off the top of my head: sanitation and urban living conditions improved dramatically as a result of the gradual replacement of horses with cars for everyday transportation. Did either the purchaser of the car or the seller of the car capture all of the benefit of this improvement that occurred as a result of their transactions? No. Therefore it is a positive externality.

Lots of things have positive externalities. Education, for example, comes to mind. Technologies that increase efficiency is another (which is the umbrella your example falls under), though they also have some negative externalities, too, usually in the form of unemployment.

Lots of things have positive externalities. Education, for example, comes to mind. Technologies that increase efficiency is another (which is the umbrella your example falls under), though they also have some negative externalities, too, usually in the form of unemployment.

I was specifically interested in the pollution angle.

Well the automobile is a good example I think, because if you consider all of the external costs of pollution (which, especially for early automobiles, was considerable) but *not* any of the external benefits of the cause of that pollution, you would have to come to the conclusion that the automobile was not a net benefit to humanity.

(I don't doubt somebody will in fact claim this, predictably because they don't actually think about all the positive changes automobiles have caused.)

Lots of things have positive externalities. Education, for example, comes to mind. Technologies that increase efficiency is another (which is the umbrella your example falls under), though they also have some negative externalities, too, usually in the form of unemployment.

I was specifically interested in the pollution angle.

Well the automobile is a good example I think, because if you consider all of the external costs of pollution (which, especially for early automobiles, was considerable) but *not* any of the external benefits of the cause of that pollution, you would have to come to the conclusion that the automobile was not a net benefit to humanity.

(I don't doubt somebody will in fact claim this, predictably because they don't actually think about all the positive changes automobiles have caused.)

One of societies problems at the moment though is that the consideration of the negatives was not done (perhaps not even able to be done due to the scientific understanding of the time) at the same time as the positives were being realized. Its this difficulty in retroactively accounting for the negative impacts of our actions that is causing so much resistance towards making (much needed) changes as it cuts heavily into the previously unchallenged operations of some pretty big industries.

One would think that maintaining a viable ecosystem for one's descendants would be incentive enough to avoid pollution.

I suppose these irresponsible industrialists are really aliens who can just leave this planet after they're done raping it.

People do: once they have the education to realize the results of their actions and the disposable income to spend on environmentally friendly solutions. Some examples would be the Clean Air and Water Act, removal of Lead from Gas on the Gov't side (in the US) or individuals purchasing more fuel efficient cars, shade coffee instead of regular coffee, etc. This only can happen with education and disposable income.

The problem then is raising education and income to levels where people have the means to care about the environment without destroying it before reaching that income level.

Market based methods don't work. The market will always drive the cost to zero.

Perfectly competitive markets drive prices to the marginal cost of production, not to zero. Most markets aren't perfectly competitive. Many aren't really competitive at all.

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Please stick with fines and enforcement actions.

Command-and-control methods of enforcement are inferior to pricing reductions into the market itself. By forcing the price to accurately reflect the true cost of pollution, you cause the market to adjust organically.

There seems to be a solution that is being overlooked here. Instead of spending money cleaning up the environment or other regulations, couldn't we spend money educating consumers about who produces pollution so they can make informed decisions?

Since the costs cannot be quantified and only estimated, the entity charged with determining the costs would be a bureaucrat and we all know how well that works. Graft, corruption, political favors... (who has the MOST Obama-care waivers? Pelosi and Reid!!). This will breed even more corruption in the government. One alternative is to let the damaged parties sue in court by proving factual costs, but those too are hard to quantify. Fines, enforcement by an agency that has good oversight by someone responsible... probably the only way to go.

Since the costs cannot be quantified and only estimated, the entity charged with determining the costs would be a bureaucrat and we all know how well that works. Graft, corruption, political favors... (who has the MOST Obama-care waivers? Pelosi and Reid!!). This will breed even more corruption in the government. One alternative is to let the damaged parties sue in court by proving factual costs, but those too are hard to quantify. Fines, enforcement by an agency that has good oversight by someone responsible... probably the only way to go.

There seems to be a solution that is being overlooked here. Instead of spending money cleaning up the environment or other regulations, couldn't we spend money educating consumers about who produces pollution so they can make informed decisions?

There seems to be a solution that is being overlooked here. Instead of spending money cleaning up the environment or other regulations, couldn't we spend money educating consumers about who produces pollution so they can make informed decisions?

You're probably right, but do we really expect to be able to protect the environment long term if most people continue to not care? I think our effort is better spent educating people on the benefits of the environment and the harm that pollution can cause. This addresses the root cause of the problem, not the symptoms.

There seems to be a solution that is being overlooked here. Instead of spending money cleaning up the environment or other regulations, couldn't we spend money educating consumers about who produces pollution so they can make informed decisions?

You're probably right, but do we really expect to be able to protect the environment long term if most people continue to not care? I think our effort is better spent educating people on the benefits of the environment and the harm that pollution can cause. This addresses the root cause of the problem, not the symptoms.

People resist education if it conflicts with their existing beliefs, or other incentives like political favor or economic gain. The US and its political clusterfuck of environmental "debate" is a strong example. Even though most Republican voters don't benefit from delayed/decapicated environmental regulation, they still rally to the cause of killing off anything that might protect the environment in embarrassingly huge numbers. Most of them get their environmental disinformation from well-connected, vested interests without even realizing it.A non-monetary example of the same thing happens with evolution in this country; there's a huge resistance to it that's disproportionately socio-political in character. It's not that people aren't being sufficiently educated (although that's definitely a factor), it's that there are others seeking to destroy the credibility of anybody trying to educate them.

You're probably right, but do we really expect to be able to protect the environment long term if most people continue to not care? I think our effort is better spent educating people on the benefits of the environment and the harm that pollution can cause. This addresses the root cause of the problem, not the symptoms.[/quote]That's the difference between being able to make the "wrong" choice anytime you want, and completely having that choice removed from the table entirely.

Example: I know bluefin tuna is almost extinct, so I choose to not order it at a restaurant. What about the person after me who doesn't know or doesn't care. (The latter case is functionally identical to the former.)

If bluefin tuna isn't on the menu at all (because it's illegal), then I can't make the "wrong" choice at all.

In the case of a green GDP, you might not remove the tuna from the menu entirely, but instead you'll force the market to account for its scarcity, by increasing the price to accurately reflect the status of the species. So instead of $30 (or whatever) it's now $300. As scarcity becomes less of a problem, the price falls again to maintain some kind of equilibrium. (What that equilibrium is an unanswered question, btw.)

In the case of a green GDP, you might not remove the tuna from the menu entirely, but instead you'll force the market to account for its scarcity, by increasing the price to accurately reflect the status of the species. So instead of $30 (or whatever) it's now $300. As scarcity becomes less of a problem, the price falls again to maintain some kind of equilibrium. (What that equilibrium is an unanswered question, btw.)

The price of the tuna would increase in either solution. Under my idea, the demand for it would decrease which drives up the price. The difference is, a free society is allowed to make that choice rather than a government regulation. Which has a better track record? I'm a believer in freedom. I believe that more free and prosperous societies produce less pollution because they can afford to be environmentally conscience (see Africa, China), so I say a freedom of choice will result in better care for the environment. This, of course, assumes you want to live in an industrialized world with modern conveniences. If you don't, then yes, poor societies who haven't even heard of technology probably produce less pollution.

The price of the tuna would increase in either solution. Under my idea, the demand for it would decrease which drives up the price. The difference is, a free society is allowed to make that choice rather than a government regulation. Which has a better track record? I'm a believer in freedom. I believe that more free and prosperous societies produce less pollution because they can afford to be environmentally conscience (see Africa, China), so I say a freedom of choice will result in better care for the environment. This, of course, assumes you want to live in an industrialized world with modern conveniences. If you don't, then yes, poor societies who haven't even heard of technology probably produce less pollution.

Why would you be emphasizing 'free' when clearly your examples are ones of prosperity? Why not instead compare countries with similar prosperity levels and different levels of 'free' market vs. government control?

Lots of things have positive externalities. Education, for example, comes to mind. Technologies that increase efficiency is another (which is the umbrella your example falls under), though they also have some negative externalities, too, usually in the form of unemployment.

I was specifically interested in the pollution angle.

I read "umbrella", and it's raining here, which made me think of how much I like my umbrella. The Planet Money link talked about the cost of pollution at the Grand Canyon. What's it worth to you to have a 10% clearer view there? That's a negative externality of pollution producers. Now, back to the umbrella -- there was a cost to produce and a price I paid. It's worth significantly more to me than what I paid for it because it keeps me dry and happy, so there's a positive externality. Wouldn't this also have to be included in the calculation? (or maybe it already is?)

It's just so difficult to price these externalities, and AbbaDabba is right; it would be left up to bureaucrats funded by special interests.

The price of the tuna would increase in either solution. Under my idea, the demand for it would decrease which drives up the price.

Falling demand (constant supply) drives price down, not up.

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The difference is, a free society is allowed to make that choice rather than a government regulation. Which has a better track record? I'm a believer in freedom. I believe that more free and prosperous societies produce less pollution because they can afford to be environmentally conscience (see Africa, China), so I say a freedom of choice will result in better care for the environment.

The price of the tuna would increase in either solution. Under my idea, the demand for it would decrease which drives up the price.

Falling demand (constant supply) drives price down, not up.

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The difference is, a free society is allowed to make that choice rather than a government regulation. Which has a better track record? I'm a believer in freedom. I believe that more free and prosperous societies produce less pollution because they can afford to be environmentally conscience (see Africa, China), so I say a freedom of choice will result in better care for the environment.

Demonstrably false.

You're right about the first part. I was thinking more long term as the fish became more of a rarity in supply. Still, in either case the demand would fall, which is ultimately what we were trying to accomplish. Not sure what you mean about the second part.

I'm just partial to solutions that address the root problem. They're cheaper and more effective in the long run. Unless you see something else as being the root problem?

Now, back to the umbrella -- there was a cost to produce and a price I paid. It's worth significantly more to me than what I paid for it because it keeps me dry and happy, so there's a positive externality. Wouldn't this also have to be included in the calculation? (or maybe it already is?).

That is not an externality that is consumer surplus. You are getting a benefit from a transaction that you agreed to partake it. The problem is when the benefits or costs spill over to individuals or groups not a party to the transaction.

It's worth significantly more to me than what I paid for it because it keeps me dry and happy, so there's a positive externality.

Technically that's not an externality, because it accrues to you, who was a participant in the economic transaction of "money for umbrella." Your utility was already accounted for in the internal cost/benefit analysis you made when deciding whether or not to buy the umbrella at the price offered. Technically, what you describe is surplus value you gained from the transaction (which is the basis for all wealth creation) - you would have been theoretically willing to pay more, but you didn't, so you get the utility of the umbrella AND the utility of the money you didn't have to spend.

An externality would be a costor or benefit that accrued to someone else who was not a participant in the decision to buy and sell.

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You're right about the first part. I was thinking more long term as the fish became more of a rarity in supply.

Remember that demand is a *curve* representing how many fish people would be willing to buy at a given price. Supply is also usually a curve and where the two intersect is the most efficient price and equilibrium market price. Now, natural scarcity will tend to compress the supply curve. The demand curve doesn't actually change at all because people's *want* of fish is relatively independent of how many fish there are (leaving aside considerations of environmentalism and hoarding). Rather, what happens is that because the supply curve is shifting while the demand curve is not, the point at which the curves intersect is lower on the demand curve, where the price is higher. The result is that even though *demand* is the same, the *price* is higher and *consumption* is decreased.

One more thing: the problem with fish stocks is one that is common to situations in which nobody owns the underlying resource, and that is that any individual producer receives all of the profits but spreads all of the cost to other producers, which greatly warps the supply curve for the producers, creating an artificially low price point and a consumption level that ultimately leads to an economically inefficient outcome (destruction of the resource.)

The two typical ways to solve this are typically to make the resource owned by someone, creating an economic incentive to manage it rationally, or to regulate it.

Nice to see some intelligent discussions on this article. I've always wondered (living in Rochester, NY), that if Kodak had to actually account for all it's externalities - including a much higher cancer rate in the area east of the factory, as well as pollution of the Genesee river and Lake Ontario (Kodak is legally allowed to dump thousands of gallons of chemicals into the river), if they would actually have made it as a company. Probably not, as other companies that did not have to pay for externalities would be able to offer the same product for less money. In the end, we built America off of the environment, and we can't continue to do so any longer. Too bad we don't have the balls to move into the Green Revolution that could generate millions of jobs and a sustainable economy for decades.

While trying to assess externalities can certainly make for a more efficient marketplace overall, I think it's helpful to remember that there are *also* external benefits as well as external costs. Focusing on just one side of the ledger does not actually help us paint a more accurate picture.

Positive externalities associated with pollution? Do tell.

Not with pollution specifically, but with commercial transactions generally.

One example right off the top of my head: sanitation and urban living conditions improved dramatically as a result of the gradual replacement of horses with cars for everyday transportation. Did either the purchaser of the car or the seller of the car capture all of the benefit of this improvement that occurred as a result of their transactions? No. Therefore it is a positive externality.

The positive externalities have been accounted for. That is why taxes pay for roads, water, sewage, parks, and other improvements that benefit society as a whole.